Roth IRA Conversions after Age 70-1/2

A Roth IRA conversion allows you to move a sum of money from a traditional/rollover IRA into a Roth IRA, pay the taxes due, and thereby convert the future distributions into a tax-free stream out of the Roth IRA for yourself or your heirs.  You probably already know that the IRS requires you to start taking mandatory distributions from your traditional IRA when you turn 70 1/2, even if you don’t actually need the money.  A Roth IRA has no such annual minimum distribution requirement for the original owner and spouse. So the question is: can you do a Roth conversion at that late date, and thereby defer distributions forever?

The answer is that you CAN do a Roth conversion at any time, including after age 70 1/2.  But that might not be ideal tax planning.  Why?  Because at the time of the conversion, you would have to pay ordinary income taxes on the amount converted—basically, paying Uncle Sam up-front for what you would owe on all future distributions.  So, from a tax standpoint, you’re either paying taxes on yearly distributions or all at once.  (Or, if it’s a partial conversion, on the amount transferred over.)  If the goal was to avoid having to pay taxes on that money until you needed it, the conversion kind of defeats the purpose. Unless, of course, you have little other taxable income, and adding a Roth Conversion amount costs you little or nothing in taxes

The traditional reason people made Roth conversions was to pay taxes at a lower rate today than the rate they expect to have to pay on distributions in the future.  They might also want to convert in order to leave the Roth IRA dollars to heirs who might be in a higher tax bracket (keep in mind that a heir who is not your spouse is required to take a minimum, albeit non-taxable, distribution from a Roth IRA).  But with the new Republican Administration taking over, and Republicans controlling both houses of Congress, tax rates are odds-on favorites to go down, not up, in the near future.

If you still want to go ahead and make a conversion after the mandatory distribution date, the law says that you have to take your mandatory withdrawal from your IRA before you do your conversion. That means that you can’t make a 100% conversion of your traditional IRA if you are subject to minimum distribution requirements.  Regardless, you or your tax advisor should “run the numbers” to ensure that you understand the taxes and tax rates that apply before and after the Roth Conversion.

If you would like to review your current investment portfolio or discuss any other tax or financial planning matters, please don’t hesitate to contact us or visit our website at http://www.ydfs.com. We are a fee-only fiduciary financial planning firm that always puts your interests first.  If you are not a client yet, an initial consultation is complimentary and there is never any pressure or hidden sales pitch. We start with a specific assessment of your personal situation. There is no rush and no cookie-cutter approach. Each client is different, and so is your financial plan and investment objectives.

Source:
http://time.com/money/4568635/roth-ira-conversion-year-turn-70-%C2%BD/?xid=tcoshare

The MoneyGeek thanks guest writer Bob Veres for his contribution to this post

Celebrity Apprentice – Presidential Edition

Can lightning strike twice? Apparently it can as pundits, oddsmakers and major polls got it all wrong when forecasting our choice for our next president. Most had Clinton winning in a landslide. The first lightning instance was their wrong call on the Brexit vote earlier this year.

With President Elect Donald Trump, you may be well advised to prepare for a potentially wild ride in the investment markets over the next few weeks; indeed, the markets turned sharply negative in the overnight futures market Tuesday due to the uncertainties ahead. However, the day after the election (Wednesday), the markets closed decisively higher than election day in an opposite reaction to a market crash which some warned about if Trump was elected.

Questions Abound: Will the new President really build an expensive wall across our Southern border?  Will he introduce legislation that will nullify the Affordable Care Act and throw millions of Americans with pre-existing health conditions into health insurance limbo?  Do taxpaying non-citizens who have children born in America have reason to fear deportation?  Are our allies abroad really going to have to renegotiate their trade and security arrangements with the world’s superpower? Will he even the score with his government adversaries, invite them into his boardroom, and tell them “You’re fired”?

It is helpful to remember that market gyrations are almost always bad times to trade, and particularly to sell.  We have more than two months before the new president takes office.  Traders and analysts have plenty of time to settle down between now and the first 100 days of the Trump presidency, and evaluate whether America’s corporations are, indeed, worth much less than they were before election night (they’re not).  The safest bet you can make is that they  may be unusually jumpy for the next four years.  But in the end, the intrinsic value of stocks doesn’t change with the occupant of the White House.

One of the more interesting things to watch out for is a tax reform proposal sometime in early 2017.  Along the campaign trail, candidate Trump proposed simplifying our taxes down to three ordinary income tax brackets: 12% (up to $75,000 for joint filers), 25% ($75,000 to $225,000) and 33% (above $225,000).  The wish list includes a doubling of the standard deduction, with itemized deductions capped at $100,000 for single filers; $200,000 for joint filers.  Capital gains taxes would be capped at 20%, federal estate and gift taxes would be eliminated and the step-up in basis would be eliminated for estates over $10 million.

However, one should remember that these proposals were made before anyone imagined that Americans would elect an undivided government, with the Presidency, the House and Senate all under the control of one party.  The next four years—indeed, the first 100 days of the new Presidency—represent an opportunity for the Republican party to do something much more ambitious than simply tinker with our nation’s tax rules.  Influential Republican leaders—including House Speaker Paul Ryan—have reportedly been planning for some years to rewrite our nation’s tax code.

What, exactly, would tax reform look like?  At this point, we simply don’t know.  The goal would be tax simplification, but the bet here is that whatever form this takes will add thousands of pages to the current law and will likely look very different from Trump’s proposal.

Of course, everything is speculation at this point, which is the most important thing to keep in mind if the markets roil and the shock and awe of the unexpected election outcome begins to sink in and cooler heads prevail.  The very worst thing you could do, over the next few days and weeks, is make a temporary loss permanent by selling into the general panic. Better yet, take advantage of others’ panic and add to your investments at prices lower than they were during the past couple of years.

If you would like to review your current investment portfolio or discuss any other financial planning matters, please don’t hesitate to contact us or visit our website at http://www.ydfs.com. We are a fee-only fiduciary financial planning firm that always puts your interests first.  If you are not a client yet, an initial consultation is complimentary and there is never any pressure or hidden sales pitch. We start with a specific assessment of your personal situation. There is no rush and no cookie-cutter approach. Each client is different, and so is your financial plan and investment objectives.

The MoneyGeek thanks guest writer Bob Veres for his contribution to this post.

Growing Pains

We measure the economic growth of the country via the Gross Domestic Product. Gross domestic product (GDP) is the monetary value of all the finished goods and services produced within a country’s borders in a specific time period. Though GDP is usually calculated on an annual basis, it is calculated and reported on a quarterly basis in the United States. After one of the worst recessions this country has seen ended in 2009, you’d think that the country would ramp up growth, but it has been anything but a ramp.

So why has the American economy grown so slowly since the Great Recession?  This year, GDP growth will fall somewhere in the 1.5% to 1.8% range, below the 3% growth rate that is considered a sign of robust economic health.  Critics have blamed everything from China’s slowdown, to globally outsourced manufacturing, and to fiscal fights in Washington.  But new research from economists at the Federal Reserve Board points to a different—and much simpler—explanation.

The researchers started with a demographic prediction model.  The model recognizes that the economy was destined to grow rapidly when the workforce is heavily weighted toward young accumulators, as it was in the 1960’s and 1970’s when the Baby Boom generation entered the workforce.  The good times continued as the labor force matured and the Boomers reached a high consumption stage of their lives.

But then the Fed economists asked: what happens when the Baby Boomers start to retire, as they did starting in 2005, and in increasing numbers since?  The boomer generation had fewer children than their parents did, so the research shows that as the workforce aged and retired, there were fewer people left in the workforce.  Economic output inevitably declined, no matter what happened in China or the manufacturing sector.

Over the past decade, the research shows that what economists call “capital”—machines, factories, roads, buildings, etc.—has become abundant compared to labor, which has depressed the return that investors receive for investing in capital.  This doesn’t just mean slower economic growth; it also leads to a decline in interest rates (due to a slowing demand for capital).  This helps explain why interest rates rose in the 1960’s and 1970’s, and have gradually declined in the subsequent decades.

The conclusion?  The U.S.—alongside many other developed nations—is experiencing a decline in workers compared with retirees, which happens to coincide with the lingering effects of the financial crisis.  The power of demography is like the tide; don’t blame the government or the Fed for not intervening, because they don’t have the power to overcome the shortage of workers (just ask anyone in Japan, suffering from one of the worst economic declines over the past twenty years due to an aging population and tight immigration policies).  More babies, and maybe more immigrants, represent better solutions.

If you would like to review your current investment portfolio or discuss any other financial planning matters, please don’t hesitate to contact us or visit our website at http://www.ydfs.com. We are a fee-only fiduciary financial planning firm that always puts your interests first.  If you are not a client yet, an initial consultation is complimentary and there is never any pressure or hidden sales pitch. We start with a specific assessment of your personal situation. There is no rush and no cookie-cutter approach. Each client is different, and so is your financial plan and investment objectives.

Sources:

http://www.federalreserve.gov/econresdata/feds/2016/files/2016080pap.pdf

https://www.washingtonpost.com/news/wonk/wp/2016/10/07/theres-a-devastatingly-simple-explanation-for-americas-economic-mess/?tid=sm_tw

The MoneyGeek thanks guest writer Bob Veres for his contribution to this post

 

Buying an Inexpensive Credit Score

It’s a classic chicken or egg dilemma: your kids graduate from college and face an immediate problem: they have no credit history, which makes it harder for them to rent an apartment or get a credit card.  But how do they get a credit history without someone granting them credit?  Is there a way the parents can help them without risking their own credit score?

An article on the website Nerdwallet suggests a solution that will cost just $200.  You encourage your child to open a secured credit card, whose credit limit is equal to a deposit that can be as low as $200.  You make the deposit on his/her behalf, and presto!  The cardholder is now able to make small purchases, pay back into the account, and establish a credit score in about six months.  And the transactions weigh more heavily in credit scoring when the adult child is a primary user, rather than an authorized user on the parent’s credit card.  An added advantage: the child receives his/her own separate bill, and becomes accustomed to paying on time.

Credit experts recommend that the child hold spending to 30% or less of the credit limit—which basically means putting no more than $60 on the credit card, and then paying that amount back.  Parents can spring for a higher deposit if they think the adult child will be responsible for making higher payments.

Make sure the new credit card holder understands the interest rates, minimum payment and due date on the statements, and help adult children calculate how long it would take to pay off the balance making only minimum payments.  Better yet, teach them that paying off credit cards in full every month is the only responsible way to handle them. Interest rates tend to be very high, potentially making this inexpensive solution a more expensive one.

Eventually, once the adult child has learned good credit card habits by using a card with training wheels, he or she can transition to an unsecured credit card.  At that point, the secured card can be closed and your deposit returned. And voila! You’ve just helped your young adult move ahead on the road to a better financial future.

If you would like to review your current investment portfolio or discuss any other financial planning matters, please don’t hesitate to contact us or visit our website at http://www.ydfs.com. We are a fee-only fiduciary financial planning firm that always puts your interests first.  If you are not a client yet, an initial consultation is complimentary and there is never any pressure or hidden sales pitch. We start with a specific assessment of your personal situation. There is no rush and no cookie-cutter approach. Each client is different, and so is your financial plan and investment objectives.

Source:

https://www.nerdwallet.com/blog/finance/buy-your-kid-good-credit-score/

The MoneyGeek thanks guest writer Bob Veres for his contribution to this post

Third Quarter 2016 YDFS Market Review

Over seven years into this bull market and the fears of a market swoon or bear market have not materialized. In fact, 100 days after the Brexit scare, nine months after the most recent Fed rate hike, the markets once again confounded the instincts of nervous investors and went up instead of down.  Last week, Fed Chairperson Janet Yellen told the world that the U.S. economy is healthy enough to weather a rise in interest rates, but the Fed governors met in September and declined to serve up the first rate hike since last December 15.  That was reassuring news to the Wall Street traders, and investors generally, helping to provide yet another quarter of positive gains in U.S. stocks.

The Wilshire 5000 Total Market Index–the broadest measure of U.S. equities—gained 4.53% for the third quarter, and is now up 8.39% for the first three quarters of the year.  The comparable Russell 3000 index was up 4.40% for the quarter and is sitting on 8.18% gains so far this year.

Larger companies posted the lowest gains.  The Wilshire U.S. Large Cap index was up 3.92% in the third quarter of 2016, putting it at a positive 8.01% since the beginning of January.  The Russell 1000 large-cap index provided a 4.03% return over the past quarter, with a gain of 7.92% so far this year, while the widely-quoted S&P 500 index of large company stocks posted a gain of 3.31% in the third quarter, and is up 6.08% for the year so far.

Meanwhile, the Wilshire U.S. Mid-Cap index was up 4.35% for the quarter, and is sitting on a positive gain of 11.31% for the year.  The comparable Russell Midcap Index gained 4.52% for the quarter, and is up 10.26% for the year.

Small company stocks, as measured by the Wilshire U.S. Small-Cap index, gave investors a 7.67% return during the third quarter, up 13.03% so far this year.  The comparable Russell 2000 Small-Cap Index gained 9.05%, posting an 11.46% gain so far this year, while the technology-heavy Nasdaq Composite Index gained 9.67% for the quarter and is up 6.06% heading into the final quarter of 2016.

Looking abroad, the U.S. remains a haven of stability in a very messy global investment scene.  The broad-based EAFE index of companies in developed foreign economies gained 5.80% in dollar terms in the third quarter of the year, but is still down 0.85% for the first three-quarters of the year.  In aggregate, European stocks have lost 2.67% so far in 2016.  Far Eastern stocks are up just 1.73% for the year.  In contrast, a basket of emerging markets stocks domiciled less developed countries, as represented by the EAFE EM index, gained 8.32% for the quarter, and are sitting on gains of 13.77% for the year so far.

Looking over the other investment categories, real estate investments, as measured by the Wilshire U.S. REIT index, were down 1.21% for the third quarter, but still enjoy a gain of 9.75% for the year.  Commodities, as measured by the S&P GSCI index, lost 4.15% of their value in the third quarter, but are sitting on gains of 5.30% for the year so far.

On the bond side, the interest rate story is essentially unchanged: rates are still low, once again confounding all the experts who have been expecting significant rate rises for more than half a decade now.  10-year U.S. government bonds are currently yielding 1.59%.  Three-month notes were yielding 0.27% at the end of the quarter, while 12-month bonds were paying just 0.58%.  Go out to 30 years, and you can get a 2.32% annual coupon yield. Looking ahead to December, the experts might be proven right as the markets currently give nearly a 2 in 3 chance that the Federal Reserve will raise short-term interest rates by 0.25%.

While it’s interesting to compare your quarterly rates of return with the above indexes, you should expect that your returns will not match them. If you have a diversified or hedged portfolio of domestic stocks, foreign stocks, bonds, real estate, commodities, etc., your blended rate of return will likely be something less than any one of the above indexes. Diversification tends to blunt overall returns, but it’s the only way to weather the ups and downs of the market over the long term.  No one should be fully (100%) invested in risky assets.

What’s keeping stock prices high while sentiment appears to be—let’s call it “restrained?”  Nobody knows the answer, but a deeper look at the U.S. economy suggests that the economic picture isn’t nearly as gloomy as it is sometimes reported in the press.  Economic growth for the second quarter has been revised upwards from 1.1% to 1.4%, due to higher corporate spending in general and especially as a result of increasing corporate investments in research and development.  America’s trade deficit shrank in August.  Consumer spending—which makes up more than two-thirds of U.S. economic activity-, rose a robust 4.3% for the quarter, perhaps partly due to higher take-home wages this year.

Meanwhile, if someone had told you five years ago that today’s unemployment rate would be 4.9%, you would have thought they were highly optimistic.  But after the economy gained 151,000 more jobs in August, unemployment remained below 5% for the third consecutive month, and the trend is downward.  At the same time, average hourly earnings for American workers have risen 2.4% so far this year.

Based on their reading of the Treasury yield curve (the rates of interest paid plotted over short, medium and long term periods), economists at the Federal Reserve Bank of Cleveland have pegged the chances of a recession this time next year at a low 11.25%.  They predict GDP growth of 1.5% for this election year—which, while below targets, is comfortably ahead of the negative numbers that would signal an economic downturn.  (In general, a steep yield curve has been a predictor of strong economic growth, while an inverted one, where short-term rates are higher than longer-term yields, are associated with a looming recession.) Other indicators that we follow give a less than 10% chance of recession over the next year.

On top of everything else, as you can see from the accompanying chart, corporate profits have been on a long-term upswing, even if the rise has been choppy since 2008.  Will this long-term trend continue?  Who knows?

ca-2016-10-1-quarter-end-report

The U.S. returns have been so good for so long that many investors are wondering: why are we bothering with foreign stocks?  A recent Forbes column suggested the answer: historically, since 1970, foreign stocks have outperformed domestic stocks almost exactly 50% of the time, meaning the long trend we’ve become accustomed to could reverse itself at any time.

Nobody would dispute that the economic statistics are weak tea leaves for trying to predict the market’s next move, and it is certainly possible that the U.S. and global economy are weaker than they appear.  But the slow, steady growth we’ve experienced since 2008 is showing no visible signs of ending, and it’s hard to find the usual euphoria and reckless investing that normally accompanies a market top and subsequent collapse of share prices.  At the current pace, we might look back on 2016 as another pretty good year to be invested, which is really all we ask for.

If you would like to review your current investment portfolio or discuss any other financial planning matters, please don’t hesitate to contact us or visit our website at http://www.ydfs.com. We are a fee-only fiduciary financial planning firm that always puts your interests first.  If you are not a client yet, an initial consultation is complimentary and there is never any pressure or hidden sales pitch. We start with a specific assessment of your personal situation. There is no rush and no cookie-cutter approach. Each client is different, and so is your financial plan and investment objectives.

Sources:

Wilshire index data.  http://www.wilshire.com/Indexes/calculator/

Russell index data: http://indexcalculator.russell.com/

S&P index data: http://www.standardandpoors.com/indices/sp-500/en/us/?indexId=spusa-500-usduf–p-us-l–

Nasdaq index data: http://quicktake.morningstar.com/Index/IndexCharts.aspx?Symbol=COMP

International indices: http://www.mscibarra.com/products/indices/international_equity_indices/performance.html

Commodities index data: http://us.spindices.com/index-family/commodities/sp-gsci

Treasury market rates: http://www.bloomberg.com/markets/rates-bonds/government-bonds/us/

Aggregate corporate bond rates: https://indices.barcap.com/show?url=Benchmark_Indices/Aggregate/Bond_Indices

Aggregate corporate bond rates: http://www.bloomberg.com/markets/rates-bonds/corporate-bonds/

https://www.yahoo.com/news/yellen-defends-tougher-banking-regulations-141913276.html

http://www.bls.gov/news.release/pdf/empsit.pdf

https://www.yahoo.com/news/u-economy-less-sluggish-2nd-165152063.html

http://www.tradingeconomics.com/united-states/corporate-profits

https://www.clevelandfed.org/our-research/indicators-and-data/yield-curve-and-gdp-growth.aspx

http://www.forbes.com/sites/wadepfau/2016/09/29/us-markets-are-outperforming-global-markets-what-should-you-do/?utm_content=38955693&utm_medium=social&utm_source=twitter#476c0e8f3308

The MoneyGeek thanks guest writer Bob Veres for his contribution to this post

Regulators to the Rescue?

By now, some of you have received one or more notices from your broker or custodian about changes to your chosen money market fund. What do these changes mean to you?

The world of money market funds changed forever back in 2008, when an investment vehicle called the Reserve Primary Fund loaded up on loan obligations backed by Lehman Brothers.  Lehman famously went under, and the fund “broke the buck,” meaning that when Lehman was unable to pay back its loans, the value of a share of the Reserve Primary Fund dipped under $1.

This was the first time many investors realized that money market funds were not risk-free.  Many panicked, causing a run on other money market instruments, and overall the event added another unhappy twist to the financial crisis.

Fast forward to the near future: October 14, 2016, the date when new protective regulations implemented by the Securities and Exchange Commission, will go into effect.  Yes, the government wheels creak along that slowly.

What regulations?  To make sure that the funds are able to redeem at par ($1 per share), all money market instruments that invest in taxable corporate debt or municipal bonds, and have institutional investors, will have to keep at least 10% of their assets either in cash, U.S. Treasury securities or other securities that will convert to cash within one day (many money market funds make overnight loans to lending institutions in the U.S. and Europe.)

As further safeguards, at least 30% of a money market fund’s assets will have to be liquid within one week, and funds will be restricted from investing more than 3% of their assets in lower-quality second-tier securities.  No more than one-half of one percent of their assets can be invested in second-tier securities issued by any single issuer.  Finally, money market funds will not be allowed to buy second-tier securities that mature in more than 45 days.

What happens if all these safeguards don’t work, and a share of the money market fund still goes below $1?  In those (probably rare) instances, the fund’s board of directors are permitted to suspend your ability to redeem your investment for up to ten days, and under certain circumstances, they may impose a 1% or 2% fee on your redemptions. That’s pretty steep, considering that you’re probably currently receiving less than a 1% return on your money market funds.

The bottom line is that investors will still be able to put $1 into a money market fund and expect to get $1 back out again when they sell shares—with, perhaps, a tiny bit more confidence a few months from now. Just don’t expect these money market funds to keep up with the pace of inflation.

If you would like to review your current investment portfolio or discuss any other financial planning matters, please don’t hesitate to contact us or visit our website at http://www.ydfs.com. We are a fee-only fiduciary financial planning firm that always puts your interests first.  If you are not a client yet, an initial consultation is complimentary and there is never any pressure or hidden sales pitch. We start with a specific assessment of your personal situation. There is no rush and no cookie-cutter approach. Each client is different, and so is your financial plan and investment objectives.

Sources:
http://www.multnomahgroup.com/hubfs/PDF_Files/Webinar_Presentation_Slides/Money_Market_Mutual_Funds_Slides.pdf?t=1439394348032

http://www.bankrate.com/finance/investing/sec-new-rules-for-money-market-funds.aspx
http://dealbook.nytimes.com/2014/07/23/s-e-c-approves-rules-on-money-market-funds/?_r=0

http://www.thesimpledollar.com/best-money-market-account/

http://www.bankrate.com/funnel/money-market-mutual-funds/money-market-mutual-fund-results.aspx?Taxable=true

The MoneyGeek thanks guest writer Bob Veres for his contribution to this post

What’s Going on in the Markets September 9 2016

On Friday September 9 2016, the S&P 500 index fell 2.4%, while the Dow Jones Industrial Average fell 2.1%.  This was the first “greater than 1%” sell-off since June, its worst single-session loss in more than two months. The drop ended a relatively quiet summer for U.S. stocks, which had touched new highs in mid-August. But despite Friday’s jarring downdraft, market internals remain solid and equity markets are within stones throw of their recent peaks. Of course, the press reports are describing it as a full-blown market panic.

Even if the short-term pullback in stocks persists, we do not believe the longer-term bull market—which has been underway since 2009—is dead. U.S. economic data has generally shown signs of strength, and an improving economy should support the stock market over the long term.

So what’s going on?  Efforts to trace the reason why quick-twitch traders scattered for the hills on Friday turned up two suspects.  The first was Boston Federal Reserve President Eric Rosengren, who sits at the table of Fed policy makers who decide when (and how much) to raise the Federal Funds rate.  On Friday, he announced that there was a “reasonable case” for raising interest rates in the U.S. economy.  According to a number of observers, traders had previously believed there was a 12% chance of a September rate hike by the Fed; now, they think there’s a 24% chance that the rates will go up after the Fed’s September 21-22 meeting. Oh the horror of a less than 1 in 4 chance of a quarter-point (0.25%) rise in short-term interest rates–sell everything!

If the Fed decides the economy is healthy enough to sustain another rise in interest rates—from rates that are still at historic lows—why would that be bad for stocks?  Any rise in bond rates would make bond investments more attractive compared with stocks, and therefore might entice some investors to sell stocks and buy bonds.  However, with dividends from the S&P 500 stocks averaging 2.09%, compared with a 1.67% yield from 10-year Treasury bonds, this might not be a money-making trade.

If the possibility of a 0.25% rise in short-term interest rates doesn’t send you into a panic, maybe a pronouncement by bond guru Jeffrey Gundlach, of DoubleLine Capital Management, will make you quiver.  Gundlach’s exact words, which are said to have helped send Friday’s markets into a tailspin, were: “Interest rates have bottomed.  They may not rise in the near term as I’ve talked about for years.  But I think it’s the beginning of something, and you’re supposed to be defensive.” My thoughts on this: pundits have been declaring the end of the bull market in bonds for many years and have been proven wrong time and time again. Statements like this are pretty worthless in my opinion. Could he be right? Sure, there’s a 50/50 chance.

Short-term traders appear to have decided that Gundlach was telling them to retreat to the sidelines, and some have speculated that a small exodus caused automatic program trading—that is, money management algorithms that are programmed to sell stocks whenever they sense that there are others selling.  After the computers had taken the market down by 1%, human investors noticed and began selling as well.

Uncertainty about central bank policy outside the U.S. was another potential cause for Friday’s volatility. On Thursday, the European Central Bank opted for no new easing moves and Japanese bond yields have continued to rise. The two events have sent a message to markets that quantitative easing (bond buying and other monetary stimulus) may have lost some of its efficacy and will not continue indefinitely.

For seasoned investors, a 2% drop after a very long market calm simply means a return to normal volatility.  This is generally good news for investors, because volatility has historically provided more upside than downside, and because these occasional downdrafts provide a chance to add to your stock holdings at bargain prices. I’ve been telling clients all summer long to expect a volatile and rocky September and October. Does that make me smart? Nope, historically, periods of calm like we’ve seen are always followed by volatility. September and October tend to be more volatile than other months of the year.  Markets have been unusually calm this summer, and prolonged periods of low volatility can make markets susceptible to news and rumors. Given the emphasis the market is now placing on Fed policy—and the uncertainty surrounding it—we wouldn’t be surprised to see markets continue to experience volatile swings when news or economic data suggest the Fed may, or may not, raise interest rates.

That doesn’t, of course, mean that we know what will happen when the exchanges open back up on Monday, or whether the trend will be up or down next week or for the remainder of the month.  Nor do we know whether the Fed will raise rates in late September, or how THAT will affect the market.

As for bonds, while rising interest rates can translate into falling bond prices—bond yields typically move inversely to bond prices—it’s important to remember that yields generally don’t move in tandem all along the yield curve. The Fed influences short-term interest rates, but long-term interest rates are generally affected by other factors, such as economic growth and inflation expectations. And even if the Fed does raise short-term interest rates again this year, I would anticipate that future rate hikes would be gradual, as inflation remains low and the U.S. economy is only growing moderately.

That said, periods of market volatility are a good time to review your risk tolerance and make sure your portfolio is aligned with your time horizon and investing goals. A well-diversified portfolio, with a mix of stocks, bonds and cash allocated appropriately based on your goals and risk tolerance, can help you weather periods of market turbulence.

All we can say with certainty is that there have been quite a number of temporary panics during the bull market that started in March 2009, and selling out at any of them would have been a mistake.  You must resist overreacting to swings in the market. Stock market fluctuations are a normal part of investing; panicking and pulling money out of the market may mean missing out on a potential rebound.

The U.S. economy is showing no sign of collapse, job creation is stable and a rise in interest rates from near-negative levels would probably be good for long-term economic growth.  The Institute for Supply Management survey for the manufacturing sector recently showed an unexpected decline, and the service sector moved down by more than economists had expected, so I will be monitoring upcoming survey results closely to see if this develops into a trend. The employment situation remains firm; new job openings hit a record high in July and new claims for unemployment remain near recent lows.

While it may be prudent to trim some profits, panic is seldom a good recipe for making money in the markets, and our best guess is that Friday will prove to have been no exception. Market volatility is unnerving, but it’s a normal—and normally short-lived—part of investing. If you’ve built a solid financial plan and a well-diversified portfolio, it’s best to ignore the noise and focus on your long-term goals.

If you would like to review your current investment portfolio or discuss any other financial planning matters, please don’t hesitate to contact us or visit our website at http://www.ydfs.com. We are a fee-only fiduciary financial planning firm that always puts your interests first.  If you are not a client yet, an initial consultation is complimentary and there is never any pressure or hidden sales pitch. We start with a specific assessment of your personal situation. There is no rush and no cookie-cutter approach. Each client is different, and so is your financial plan and investment objectives.

Sources:

http://www.bloomberg.com/news/articles/2016-09-08/gundlach-says-it-s-time-to-get-defensive-as-rates-may-rise

http://www.forbes.com/sites/laurengensler/2016/09/09/stocks-fall-worst-day-since-brexit/#3a9ed7252961

http://www.bloomberg.com/news/articles/2016-09-09/split-among-fed-officials-leaves-september-rate-outlook-murky?utm_content=markets&utm

http://thereformedbroker.com/2016/09/09/dow-decline-signals-end-of-western-civilization/?utm

https://www.treasury.gov/resource-center/data-chart-center/interest-rates/Pages/TextView.aspx?data=yield

The MoneyGeek thanks guest writer Bob Veres for his contribution to this post